Monday, June 29, 2015

Wages and inflation

Marty Feldstein has a very interesting opinion piece on Project Syndicate. His main point is that micro distortions from social programs (and taxes, labor laws, regulations etc.) are leading many people not to work, and is well stated.

An introductory paragraph poses a puzzle to me, however,

Consider this: Average hourly earnings in May were 2.3% higher than in May 2014; but, since the beginning of this year,
hourly earnings are up 3.3%, and in May alone rose at a 3.8% rate – a clear sign of full employment. The acceleration began
in 2013 as labor markets started to tighten. Average compensation per hour rose just 1.1% from 2012 to 2013, but then
increased at a 2.6% rate from 2013 to 2014, and at 3.3% in the first quarter of 2015.

These wage increases will soon show up in higher price inflation.

This is a common story I hear. However I hear another story too -- the puzzle that the share of capital seems to have increased, and that real wages have not kept up with productivity.

So, maybe we should cheer -- rising real wages means wages finally catch up with productivity, and do not signal inflation. The long-delayed "middle class" (real) wage rise is here.

I'd be curious to hear opinions, better informed than mine, about how to tell the two stories apart.

11 comments:

Will increased wages (and other income) result in demand pull inflation? You need to compare total income with the personal savings rate - if wages (and other income) are rising and the personal savings rate is rising in lockstep, then there will likely be no demand pull inflation.

Will increased wages generate cost push inflation? You need to look at how other costs are moving relative to wages. If wages are rising and other costs (raw materials, taxes, financial capital, physical capital costs) are falling in lockstep, then increased labor costs will likely not result in cost push inflation.

And finally, total labor costs are a function of two factors - wages per hour and hours worked. If wages per hour are rising, but hours worked are falling, then it's a push.

Possibly a statement of the obvious this, but if wages rise and prices don’t then profits must fall as a proportion of GDP. That’s basic maths. So that would be your “middle class" (real) wage rise”.

My second and possibly equally useless observation is that the changes in profits as a proportion of GDP since WWII seem to be related to nothing at all. They certainly don’t seem to be related very strongly to booms and recessions.

But there must be SOMETHING causing that relationship to change. What is it????

1. Technological Progress - I pay a group of wagon builders $5.00 per hour and charge $100 per wagon that I sell. I then teach those wagon builders to make automobiles, pay them $30.00 per hour and sell automobiles for $1000 each.

Workers wages have risen, but now they are building higher order goods with a different price structure.

2. Instead of paying a person $10 / hour to work 40 hours a week, I pay them $20 / hour to work 20 hours per week.

Wages per hour have risen, total employee compensation stays the same.

: Prof. Feldstein mentions some specific barriers to job creation and says that he could list more. One barrier (from the worker side) that I come across anecdotally is the influence of family law and current social attitudes to family formation and breakup on decisions affecting how hard a person works. In popular articles, the discussion is framed as a "marriage strike" or "men going their own way". It would be interesting to hear from the economists in the room about whether those attitudes and presumably behaviours show up in this kind of data.

I understand that Feldstein is eager to show we are at full employment, as evidenced by an accelerating rate of wage and compensation increase. However, I'm not convinced there has been an acceleration. If you look at historical compensation per hour changes, especially annualized quarterly changes, they jump all over the place. Month-to-month changes in SA average hourly earnings are also volatile. Even the December-to-May change in AHE may be misleading if the seasonal pattern this year is different from earlier years because of the unusual weather pattern especially in January and February. I'd wait at least a few more months before drawing any conclusions about possible acceleration.

Ralph M. You are puzzled that profits don't seem to have a strong relationship to GDP growth. You can resolve your puzzle by referring to the "Kalecki equation", with which you may be familiar if reminded. After-Tax Profits = Net Investment plus Consumer Spending in excess of Wages plus Net Exports plus Government Deficits. This is an identity where the right side of the equation, in effect, represents the net impact of the sum of aggregate business revenues minus the sum of business costs. For example, if you spend more than your wages, that increases profits as your spending is a business revenue and your wages are a business cost.

You are correct in your observation. For example, in recent years profit growth has been strong despite sluggish economic growth, with profit margins at record highs. The two primary reasons for these record margins are (a) deficits are still running well above historical averages - which include $200B in State and local deficits and (b) the personal savings rate is only about half what it was in the 60s, 70s, 80s etc.If you are interested in seeing these components for the past 50 years search, for example, "Montier "What goes up must go down" 2012". Montier is the chief strategist at GMO (Jeremy Grantham's firm). He also explains the logic.

Regarding Dr. Cochrane's question, It might be possible for both stories to be correct. Higher wages are an increase in business costs. However, to the extent these higher wages are spent, business revenues increase -offsetting the higher costs. Hence, higher wages don't typically have a significant impact on profits - at the macro level. If other sources of business profits are growing while wages grow - it would then be at least possible for both "labor" (wages) to be gaining (but not, as explained, detracting materially from profits) and profits (return on "capital") to be growing even faster.

Yes, there should be less structural impediments in labor markets. We should also cut "national security" spending in half.

I think an independent observer would regard tight labor markets as a positive, as well as rising wages. There was a long-ago time, so long ago in that it was in 1992, that Milton Friedman bashed the Fed for being too tight. Inflation was then running at 3 percent.

When did inflation become the end all be all of macroeconomic policy?

So we have tight labor markets and 3% inflation - - - is that a bad outcome?

Pr. Feldstein wrote:"For example, someone who receives $8,000 a year in transfer payments (such as food stamps, housing assistance, and the Earned Income Tax Credit) might be deemed to have received the equivalent of $4 an hour toward meeting the minimum wage. That individual’s combined income would be achieved with a lower cost to the employer, increasing the individual’s ability to find employment."

That is exactly what is happening all of the time. The vast majority of people who receive Supplemental Nutrition Assistance Program (SNAP) have jobs or are children or are elderly. Almost 104 MUSD worth of food stamps were used at military commissaries in 2013. In addition, nearly 1 million veterans participate in SNAP as well. One of largest group of recipients are Walmart employees, most whom earn so little that they qualify for SNAP, Medicare, and other forms of public assistance.

Rather than "distortions" which limit people entering the workforce such "transfer payments" are subsidies to low pay employers which encourage workers to enter the workforce. It is the sort of subsidy which masks just how far the economy of the United States is from maximum employment.

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About Me and This Blog

This is a blog of news, views, and commentary, from a humorous free-market point of view. After one too many rants at the dinner table, my kids called me "the grumpy economist," and hence this blog and its title.
In real life I'm a Senior Fellow of the Hoover Institution at Stanford. I was formerly a professor at the University of Chicago Booth School of Business. I'm also an adjunct scholar of the Cato Institute. I'm not really grumpy by the way!